What has changed with MF portfolios
Domestic mutual funds have unflaggingly pumped money into Indian stocks in 2008, even as foreign institutional investors have been queuing up at the exit doors. With valuations for many fancied stocks and sectors ruthlessly whittled down, buying opportunities have certainly been aplenty in this period. But where have the managers of India's largest mutual funds actually seen buying opportunities? Which are the sectors they have stayed away from? Have they used the ya wning valuation gap between large and mid-caps to add to the latter?
Business Line sought answers to these questions by going over the portfolios of the 15 largest diversified equity funds starting from August 2007 to May 2008. The analysis shows that last year's hot sectors capital goods, metals, banking and financial services are still on the "buy" list, though a few funds have also pegged up allocations to defensive sectors such as IT services and pharmaceuticals, in deference to a choppy market.
Funds have treaded cautiously in the mid- and small-cap stock space. Though valuations are way off their peak, fund managers certainly haven't dived in to buy at every dip, going by the increased cash positions in portfolios.Staying with banks, cap goods
Banks, capital goods, petroleum and energy continue to be among the top five sectors held by large funds from August 2007 to May 2008. Sticking with these sectors has resulted in equity fund NAVs rising to stratospheric heights in the rally to early January 2008, only to collapse as rapidly in the meltdown.
The above sectors generated whopping returns ranging between 63 and 92 per cent in the August-January market rally. In the subsequent unravelling, on the back of global cues and local slowdown fears, these indices lost 30-45 per cent. For mutual funds, concentrated positions in these sectors meant that the long and winding market fall from January led to huge erosions in their NAVs.
Bank stocks were among the worst performers in the recent fall. But funds that already held "overweight" positions in bank/financials last year have had the conviction to stick with their choice. HDFC Equity, HDFC Top 200, Fidelity Equity and HDFC Taxsaver, for instance, have used the meltdown as a buying opportunity, adding to their bank exposures. Others such as Reliance Equity and HDFC Top 200 retained banks among top five sectors, but don't appear to have added to the segment.
That the funds continue to put these sectors on top of their radar suggests they remain convinced that the lower valuations more than factor in any earnings concerns surrounding these sectors. Sectors such as financials or infrastructure may recover quickly if concerns on credit growth and execution delays abate.
Interestingly, one bus the top funds have missed is the rally in commodity stocks. Despite the huge rise in steel prices and the rally in steel stocks (BSE Metals index soared 91 per cent in August-January) this sector has been under-represented in the top five sectors across funds.
Reliance Growth and Magnum Global were among the few to feature significant exposure to metals in this period. Most equity fund managers have been cautious on commodity stocks. This suggests that investors seeking to participate in the commodity theme should seek to diversify into commodity stocks or natural resources through specialised funds, rather than through diversified funds.Construction not favoured
An interesting aspect of the rally late last year and even this year's fall in the market has been the absence of the construction/realty sector in the top five sectors held. Incidentally, the BSE Realty returned a thumping 90 per cent in August-January but dropped nearly 60 per cent since. Neither during the rally nor the fall was this sector among the top ones held.
Many funds appear to have given the sector a wide berth due to premium valuations and ambitiously priced IPOs. Concerns that triggered the fall may be a tight interest rate scenario, making home loans dearer and correcting realty prices.
Though some of the companies in this sector reported manifold profit growth, the concerns remain.No defensive play
Among the "defensive" sectors that have weathered the correction well, fund managers have capitalised on the run-up in pharma and, to an extent, frontline IT stocks. Funds such as HDFC Equity, Reliance Equity and Fidelity Equity, which already had pharma stocks among their top five exposures, raised weights to the sector (or didn't book profits).
However, only a few funds featured sizeable exposure to frontline software stocks or FMCGs. From the portfolio changes over these 10 months, it appears that funds which held a fundamental view on the pharma sector continued to hold it among the top five. None decided to buy them afresh as a defensive measure.
The rupee depreciation against the dollar from March this year is a positive for pharma and IT companies' realisations. But two sectors that are regulatory dependent telecom and chemicals/fertilisers had only a few takers among the top five sector holdings.Lightening weights
While retaining exposures to sectors such as capital goods or banks, funds have opted to lighten the risk on their portfolios by reducing concentration in individual sectors and stocks. The exposure to capital goods and banks, which was above 25 per cent in some cases in August and January, has now been reduced to well below 20 per cent. Take HDFC Equity Fund. From being the top sector exposure at 24 per cent of the portfolio in August 2007, the fund's capital goods allocation is down to about 12 per cent in May 2008; but the sector remains among the top five choices.
Exposure to individual stocks has also been toned down. From 8-10 per cent exposure to individual stocks in August 2007 and January 2008, many funds have taken down their weights in top stocks to as low as 3-4 per cent!Mid-cap and small caps
Mid- and small-cap stocks have fallen into their classic pattern over the past year zooming ahead during the rally and tumbling like nine-pins in the correction. Mid-cap and small-cap stocks rallied ahead of the Sensex in the August-January period, their respective BSE indices gaining 51 and 67 per cent respectively. But with the subsequent fall of 35 and 42 per cent respectively, these stocks are now at a wide valuation discount to large-caps.
The PE multiples for these indices stand at 11-12 times their FY08 earnings, against the Sensex PE of 18 times. Despite this, large equity funds have only maintained or decreased their levels of exposure to such stocks. Even funds such as Magnum Global and Reliance Equity opportunities, historically skewed towards mid-caps have not pegged up exposures at this stage.
Fears of how such companies may weather a tough macro environment and volatility of earnings may have resulted in funds preferring blue-chips that have better earnings visibility and are more liquid.Cash positions
From August 2007 to June thus far this year, MFs have been net buyers in equity to the tune of Rs 14,030 crore. However, large funds have also increased their cash position in the months to May 2008, in some cases to as much as 29 per cent of their portfolio.
The higher cash position suggests that fund managers continue to be wary of the near-term outlook for the market, despite the sharp correction and may still be in "wait-and-watch' mode.Key takeaways for investors
From a stock-specific perspective, if you want to follow in the fund's footsteps, retain exposures to stocks from sectors such as banks and capital goods as fund managers still seem to be optimistic on these. It may, however, be too late to add significantly to defensive sectors such as pharma or FMCGs, after the run-up in their valuations over the past six months.
Caution may still be warranted on mid-/small-caps; better stay with frontline stocks if you intend to buy afresh. Cash positions also suggest that the short-term outlook for the market is not particularly buoyant.
From an equity fund investor's perspective, avoiding theme funds and lump-sum investments may be good de-risking measures, given the current market volatility. Large-cap oriented funds with a good 5 year track record may be best in this situation.
Funds such as HSBC Equity, Sundaram Select Focus, DSPML Top 100 Fund and HDFC Top 200 appear to be good options, which may gain from any market upside. If anything, timing the market is more utopian than ever. In such an environment, it would be prudent for risk-averse investors to take the SIP route to investment.
While there may be serious concerns now as to if and when a market bounce-back will happen, now is as good a time as any to kick off disciplined investing in diversified equity funds